Product Safety and Liability with Deceptive Advertising and Moral Hazard

Product safety is jointly determined by product quality and consumers’ precaution efforts when using products. Product failures because of either party’s negligence can cause deaths and injuries. The strict liability rule holds firms fully responsible for damages, whereas the comparative negligence rule allocates responsibilities based on the firm’s negligence in product quality and the consumer’s negligence in precaution efforts. This paper examines how these two common product liability rules affect firms and consumers when firms can advertise product quality deceptively and consumers exert precaution efforts endogenously. Common wisdom suggests that the comparative negligence rule shifts responsibility from firms to consumers, which benefits firms and motivates consumers to exert precautions to improve safety. However, we find that comparative negligence incentivizes firms to use deceptive advertising, whereas strict liability induces firms to advertise low product quality more truthfully. The latter can induce consumers to exert precaution efforts to avoid product failures, thereby improving firm profit and product safety. Moreover, raising firms’ penalties or the amount that firms compensate consumers for product failures can benefit firms but reduce consumer surplus and product safety. These findings caution public policymakers and firms that with asymmetric information about product quality and endogenous precaution efforts, liability policies can lead to unintended consequences.